Get out of debt first?

Question

We are brand new.  We are dying to jump in with both feet, but want to be smart about it.

I've got a great day job and do OK on the side with my voiceover business, but it basically all goes to pay the bills.

I'm putting 13% away in my 401k every paycheck, but not saving anything else.

Do we pay all our debt off and and build up our savings outside the 401k before investing in real estate?

Thanks for your thoughts.

Trevor & Leila

Paul Ewing · Answer

Personally I would get rid of the CC and Medical debt before buying any property.  Continue to study and browse the market, but that much debt is a danger sign to me.

You need to have positive cash flow in your personal finances before embarking on your REI. Then build up enough savings to cover a couple months of property expenses in case it takes longer to get income from your property that expected.

Personally I was totally debt free before I bought my REI properties and it made things much easier.  I still max out my 401k but have placed the $12,000 a year for my and my wife's IRAs on hold this year to use for REI because I think the stock market is getting close to a high.  You might want to scale back your 401k contributions and put it on the CC debt at least since it will be very optimistic to think you can match double digit rates of return in the market for much longer.

Shane Pearlman · Answer

Hey @Trevor & Leila Jones

That is a wonderful question. There are so many ways to answer! I'll pick a few thoughts:

#1. The value of your debt

@Eddie T. asked the right questions. Not all debt is created equal. 29% credit card debt should be cleared ASAP. 1.9% student loan debt, is something to consider carefully.

I read a wonderful book on debt management (4 laws of debt free prosperity) when we were trying to answer the same question and it laid out a really solid roadmap for getting out of our early 20s debt. It is a super quick read and a fun book.

Today, it is a question of returns. When I pay off debt, it is a guaranteed return on future income. The question is, am I confident that I can create higher return with an investment? I know I can beat 2%. Two years ago we actually put 80k cash into an existing property of ours to bring the Loan to Value Ratio to where we could refinance a 6.5% interest loan to a 3.75% interest loan. The result was a different of $2,100 a month, over 25k a year in revenue. That was a 31.5% return. I might have found better returns elsewhere, but this was guaranteed return, totally risk free. Best deal I did that year!

#2. Risk tolerance & lifestyle will define the playing field

How close to the edge can you and the family tolerate? I mention both because you have to be unified in this or it can being challenges to your relationship.

My wife and I made a deal early on. As long as we have 6 months of living expenses accessible, then everything else can go into properties. I have other friends who have 1 month but open lines of credit / credit cards. I think that is bat shit crazy. On the other hand, I have a buddy who thinks I am way too risky and should keep 1 year of cash. You might start with having a conversation with your partner on what the family thresholds are. I don't see a lot of people talk about peace of mind on this forum, but holy cow is that key. No point in making mad returns to only find yourself fat, stressed and divorced. Before you consider spending money to invest, make sure you have the personal fundamentals covered.

Our first rental was a duplex. We lived on one side and rented the other. Living next door to your tenants is an acquired taste. But it allowed us to get a loan as an owner occupant that made this deal work when it would not have otherwise. So perhaps mixing personal and investing could be a path like it was for us.

#3. Your assets come in more forms than money.

Money is the most obvious form of leverage in real estate investing. That said, there are a lot of other ways to create returns. Time, sweat equity (doing things with your own hands), control of opportunities, domain knowledge, management, relationships among others are something you can bring to the table.

I'm currently under contract to sell a home in which I have almost no personal capital invested. It is a long and complicated story (totally worth a beer), but in 2011 I ended up getting a home in a really nice neighborhood under contract. It needed remodeling and had enough margin to do a nice flip with additional solid upside if we were willing to wait for the market. I approached some family members with the deal for advice (I was planning to put my own cash in) and was asked if they could partner. In the end, we worked out a deal in which they put in all the initial capital, and I got the loan (in my name only), managed the property, was on the hook for any losses if that were to occur, ran the remodel and the finances etc. They wanted to be a hands off, minimal risk / exposure investor. They get all initial investment back first, and then we split profits. Three years later, my wife and I are netting about 85k from the sale (and we had three years of nice cashflow) and my partner got a 105% return on their investment. We are all stoked.

I put in a crazy amount of work for a few month, learned a ton, and it was a great investment.

#4. Self Directed IRAs

I don't know too much about these, but if you have solid funds in your retirement accounts, it might be a place to start from which you can gain experience.

Best of luck and let us know what you end up deciding. Give a vote if you found it helpful.

Aaron J Sawyer · Answer

Debt free just makes life less stressful. Just speaking for my own family, it feels very powerful to know that I'm not paying interest to owe other people money. My husband and I paid all our debt (mortgage, student loans, credit cards) off as soon as we could so that we had maximum control of our allocation.

Though captial growth can seem stymied by using your money to pay off debt, the month to month feeling of getting your whole check to yourself is a peace dividend.

John Thedford · Answer

I agree with the other posters. Get rid of credit card debt..and in my opinion the sooner the better. If you do buy an investment property and finance it, you can deduct the interest on your federal tax bill. You cannot deduct credit card interest in most instances. Get rid of "bad" debt. Investing in real estate and using leverage has tax advantages as well as allows you to control more properties with less cash. Some investors are averse to debt. In my personal investing, I am not a fan of debt BUT I do borrow some to help achieve certain goals. There is an article Brandon just wrote about seasoned experienced investors going broke. The gist of the article is too much leverage can bury an investor. That being said, don't be afraid to take on good debt that covers itself and gives you an income, but don't be too quick to assume lots of debt without financial backup and proper planning.

Eddie T. · Answer

@Trevor Jones 10k a month in expenses is alot. Find out which expenses can be cut or reduced, then pay off those credit cards one by one pay off the one with the smallest balance first and so on until all of them are paid off.

Ricardo S. · Answer

From what I know. If you are going to do real estate via a loan. Your debt to income ratio is a big factor so its best to pay off all major expenses starting with the one with the highest interest.

Personally I dont believe in 401ks. if you put that 13% in a joint savings, after a year or so you can use that to start your real estate campaign which will eventually become your 401k.  Thats my personal belief. So its like this at least for me;

Buy and holds are for the long term. They appreciate in value and give you monthly income.

Elizabeth Colegrove · Answer

@Trevor & Leila Jones

So debt is your friend depending on risk and use. We personally have a car loan because it is 0% and it seems silly not to leverage the car money into houses. On the other hand we had a 0% credit card but it is expiring. For me it is too stress full to carry that loan. i am paying it off next month before it comes due and being gone.

For me the length of the term is very important. i would get rid of the plastic adn medical bills. I don't mind having a car payment but that is up too you!

Do you own a personal residence? We got started by investing in a personal residence and renting it out when my husband was transfered. It is MUCH easier to get your feet wet with an personal loan than a investment.

Trevor Jones · Answer

@Shane Pearlman & others that responded Thank you!  (got to figure out how to add multiple @'s!)

Leila here, Trevor's wife.  Thank you for the response to Trevor's debt question.  He told me about the post this morning.  in essence I said we need to lay it out and see where the best allocation of money going out will produce the best yield.  Thanks again for the insight.  We are both extremely driven and have been successful in business ownership for years.  Ricardo S. we discussed this morning about trimming the 401K to 5% so we get the employee match, thank you for challenging the 401K.  It's worth running the numbers.and weighing it out.  When we become a team we are pretty unstoppable.  We will keep you updated.  This is good for accountability.

Trevor Jones · Answer

Welp...

14k on one car

29k on the other

25k in plastic

4k in medical

Low interest on the cars, teens on the plastic, none on the medical

Net monthly income is about 10k (after taxes, health, dental, vision, 401k and FSA deductions).  Can be more or less depending on my side business.

Expenses are... about 10k per month, depending on how much I pay down the plastic and medical.

Get out of debt first?

Most Popular Reply